Bemoaning a dearth of liquidity is one thing, but actually quantifying it is more difficult. Is liquidity just a measure of how much trading is being done? Or is it a measure of the ability to do deals at reasonable prices?

It has to be both, according to specialists at Morgan Stanley, who are developing analytical technology that would enable clients to observe liquidity conditions at different times of the day and so determine when and how they should execute trades.

Pete Eggleston, head of quantitative solutions and innovations at Morgan Stanley, said: “This came about because clients had been asking us to compare current liquidity conditions to those of 2011. The interesting thing was that while volumes are fairly resilient, traders said they felt liquidity has been significantly worse this year than in 2011.”

Seeking to illustrate that impairment in liquidity, the bank has homed in on two key metrics: trading volume and so-called “sweep-to-fill” cost – a measure of the amount an investor would potentially need to pay to sweep the order book at a particular time to trade a certain size. If the cost is high, it indicates a high level of risk aversion among market-makers.

While trading volume represents what is actually happening in the market, and could be thought of as liquidity demand, the sweep-to-fill cost represents the depth of the market, and so could be thought of as liquidity supply, according to Eggleston.

Eggleston said: “Liquidity is a commodity like anything else and it comes at a price, so we need to look at the balance between demand and supply. This metric captures market-maker risk aversion, because a healthy supply of liquidity is indicated by a low sweep-to-fill cost – something that would not be captured by looking at trading volume in isolation.”

When trading volume is plotted against sweep-to-fill cost, a unique illustration of liquidity is created for different currency pairs. Morgan Stanley uses four coloured quadrants to highlight the liquidity regime – so if volume is high, and sweep-to-fill cost is low, the trading opportunity would sit in a green quadrant, whereas if the reverse were true then it would migrate to a red quadrant.

The tool shows the position of a particular currency pair in comparison to where it was at exactly the same time in previous weeks, so that trends in the liquidity of particular currency pairs can be identified.

“By better understanding liquidity regimes, clients can make more informed trading decisions. If EUR/USD is in the red zone at a certain time of day, for example, that indicates a thin order book and low volumes, and it may be more appropriate to transfer the market risk to a bank immediately, whereas if the regime analysis indicates better liquidity conditions, then a more passive algo may be beneficial,” said Eggleston.